Limited company or sole trader?

Should I set up a limited company or operate as a sole trader? This is one of the first questions that you will encounter when embarking on the journey of becoming an entrepreneur. This article will help you to decide.

Perceived benefits of limited companies

There are several benefits to incorporating (setting up a limited company):

Increases your chances of securing clients. Some clients are willing to deal with limited companies only.

Makes your business appear more professional

Limits your liability to the company

However, some people are deterred by the prospect of additional administration of running a limited company. For this reason alone, they often choose not to incorporate but operate as a sole trader. The next question is – are they missing out?

Compare the tax bills

Let’s leave aside all the above qualitative factors, and compare the tax bills of the two operating models side by side.

Tax

Sole Trader

Limited Company

National insurance contribution

9%

As low as 0%

Corporation tax

N/A

20%

Tax free allowance on income

£11,850

£11,850

Income tax rate

20%/40%
(on profit)

7.5%/32.5%
(on dividend)

Tax free allowance on dividends

N/A

£2,000

As you can see, operating as a sole trader you will firstly have to pay national insurance. This is based on the profit you make and kicks in at £6,205 (class 2) and £8,424 (class 4). On top of that you will have to pay income tax on profit beyond personal allowance. Operating as a limited company you will need to pay corporation tax on the company’s profit, and income tax on the salary and dividend you take out, but you can minimise national insurance contribution if you structure your salary correctly.

Who wins? – It depends!

In summary, after considering all the above factors, you can draw a dividing line – if your business makes less than £14,500 gross profit, operating as a sole trader will maximise your take home pay. If your business makes more than £14,500 gross profit, operating through a limited company will maximise your take home pay. Here, gross profit = revenue – all costs excluding your salary. Both scenarios assume that you don’t have any other income. The table below illustrates the difference in take home pay at various profit levels.

Profit excl. salary

Net income asLimited Company

Net income asSole Trader

Net income difference

10,000

9,701

9,705

(4)

20,000

17,504

17,175

330

30,000

24,997

24,275

722

40,000

32,489

31,375

1,115

50,000

41,044

38,000

3,044

60,000

46,512

43,800

2,711

70,000

51,979

49,600

2,379

80,000

57,447

55,400

2,046

What if?

What if you have other income? such as employment income, property income. Well, the £14,500 line will apply to the total of your other income and the business gross profit.